The federal government has set up a tax system to collect a certain amount when you die if you leave an estate over a certain amount.  This tax was originally intended to prevent extemely wealthy families from holding on to their fortunes from generation to generation instead of turning assets back to the government to help run the country. 

In determining your taxable estate, you are generally allowed to deduct any debts the estate has (excluding estate tax), any expenses paid to the executor, attorneys or accountants in settling the estate, and qualified charitable donations.The estate tax will be gradually phased out and ultimately repealed in 2010. However, if Congress takes no further action, pre-2001 tax rules will be automatically reinstated in 2011. During the phase-out period, the estate tax continues with the exclusion amount gradually increasing from $1 million in 2002 to $3.5 million in 2009 and the top estate tax rate gradually decreasing from 50% in 2002 to 45% for 2007 and later years.

The stepped-up basis of dealth rules will be repealed along with repeal of the estate tax in 2010. Therefore, most property acquired from a decedent will also lose its income tax-free treatment, leaving life insurance as possibly the only tax-free benefit to heirs. For other estate property, a modified carryover basis rule goes into effect, meaning that the basis of assets received from a decedent will carry over from the decedent, rather than be stepped up to the date of death fair market value as under current law.

However, $1.3 million of basis can be added to certain assets (an additional $3 million to assets transferred to a surviving spouse). Property acquired by a decedent from a non spouse within three years of death will not be eligible for this basis add-on, nor will property that constitutes "income in respect of a decedent," which is property that has accumulated untaxed income.

Retirement plan benefits, IRAs, and nonqualified deferred annuities are generally regarded as "income in respect of a decedent" and thus may not be eligible to receive a post-death basis allocation.

Gifts above $1 million are taxed at top income tax rates. Beginning in 2010 (when the estate tax is repealed), gifts in excess of a lifetime $1 million exemption will be subject to a gift tax equal to the top individual income tax rate at that time.There are a number of techniques, some of them fairly easy to implement, that can be used to minimize estate taxes and preserve more of the estate for the heirs.  Note: Consult with an estate attorney for further guidance.